Commercial property investments explained

There was a time, back in the dim and distant past (about 30 years ago), when it was straightforward to generate an income from your savings: you put it into a saving account and got 15% interest. In the intervening years it has become far more difficult.

With hundreds of savings accounts failing to keep pace with inflation - let alone provide an income - people are having to look elsewhere. And for many people that means a commercial property investment.
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This year there has been all sorts of optimism about commercial property funds. Some experts suggest that they could return 10% this year - and next year too. That's an attractive option for income seekers: but before you jump in with both feet, it's worth understanding what's involved.

What is it?

Commercial property covers a vast array of different kinds of properties, from swanky shopping centres, to city offices, factories, workshops, and dull industrial units on the outskirts of town.

In theory, you can buy yourself a workshop or shop, and rent it out to generate an income. In reality this isn't terribly common, because the outlay can be significant, and you bear a great deal of risk if you cannot find someone to rent it, or if the overall value falls.

The way most people invest is to put their money into a 'fund' - operated by a fund manager like Henderson, Threadneedle, or SWIP. They gather money from many thousands of investors and buy up properties they like the look of. Any costs of running the properties come out of the fund, and any rent they receive on the properties goes in. When they think the time is right, they will sell the property, and the fund will benefit from any increase in price too.

This spreads your risk, because they will have a number of properties, so if one does badly, the effects will be diluted by those that have done well.

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The issues

This sort of fund is far from far from risk-free. This isn't like a savings account, because your money isn't guaranteed. Not only could the funds grow less than predicted, but they could shrink too, and you could lose a chunk of your cash. Commercial property tends to do well when the economy is booming and suffer during downturns, so between 2009 and 2012 many of the funds lost value.

The next couple of years are thought to be relatively positive for the funds, but there are no guarantees, and it's less clear what future years hold in store for commercial property funds too.

In tough times, there's also the danger that a number of people try to get out of their investment at once. It's not always easy for the fund to sell a property in order to free up the cash to pay everyone back, so sometimes they will put a block on people exiting the fund until they have managed to make a sale. This means you risk being forced to leave your money in the fund when you have already decided it's not a great place to be invested.

The advantages

The big advantage is the potential gain in the value of your investment - plus the income you get from rents along the way - which is a big draw for people chasing income.

And while the value of the fund will go up and down, technically commercial property shouldn't suffer quite as severe volatility as the stock market. This is because even when the value of the property itself falls, in many cases this will be offset to a large degree by the rental income. And with many tenants on long leases of five years or more (and defaults relatively low), the rental income is pretty stable.

Advisers like people to hold commercial property alongside stock market funds and cash savings. This helps spread the risk, because if, for example, commercial property is doing badly, it could be cancelled out to some extent by gains in the stockmarket - and vice versa.

In order to decide if a property fund is right for you, you need to weigh up the pros and cons, and ideally talk to an expert about the balance of funds that will best suit your needs and your attitude to risk.

Because while the idea of income of 10% may be very tempting, walking into any kind of investment without fully understanding it is a recipe for disaster.

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